After the bumper 50 basis points (bps) rate cut in the June policy and the change in policy stance to “neutral”, we think of the Reserve Bank of India (RBI) like a cautious driver on a foggy road — not hitting the brakes unless it absolutely has to.
The central bank’s “neutral” stance signals one thing loud and clear: the bar for a rate cut is sky-high. Growth and inflation would have to veer significantly off course from RBI’s projections before they tap the brakes.
Still, we expect one more rate cut may be on the table, probably in December.
Why? Because inflation is turning out to be tamer than expected.
Our forecast for FY26 CPI inflation is tracking at just around 3 percent and that is even after some cushion for potential food-price shocks. As we dig a little deeper, the picture gets even more convincing.
Over the past year, core inflation, which strips out food, fuel, and volatile items, has averaged just 3.7 percent. Our FY27 CPI inflation estimate sits at 4.2 percent, compared to the RBI’s 4.5 percent. Any potential shift in the CPI base that lowers food’s share and raises that of core may put additional downward pressure on inflation.
On the growth side, we are not seeing red flags. Our FY26 GDP growth estimate is 6.3 percent, only a notch below RBI’s 6.5 percent. That said, the RBI’s long-term growth aspiration of 7-8 percent still seems out of reach under current conditions.
If the RBI is serious about achieving its aspirational growth target, it may need to consider rate cuts sooner rather than later. And if inflation is the sole justification for easing, now may be the most opportune moment, especially as headline inflation is expected to slip below the 2 percent mark in July — our estimate is 1.3 percent — and taking into consideration RBI’s preference for frontloading on rate cuts.
Powell stays the course, September policy on radar
The US Federal Reserve left interest rates unchanged at 4.25 percent-4.5 percent for the fifth straight meeting, but for the first time since 1993, two voting members dissented, favouring a rate cut. It highlights growing divisions within the Federal Reserve Open Market Committee (FOMC) and could signal early positioning ahead of a leadership shift in 2026.
The policy statement saw only minor tweaks, acknowledging continued uncertainty and slowing growth in early 2025. Inflation is still "somewhat elevated", while the labour market remains solid. The overall message: no big change in the Fed’s view, just yet.
Chairman Jerome Powell struck a cautious tone, playing down chances of a September cut. He said inflation is still too high and financial conditions have eased, justifying the Fed’s wait-and-watch stance. While tariffs are pushing up goods prices, the Fed appears willing to look through this unless inflation becomes sticky.
A September rate cut remains a close call. Markets see a greater (>50 percent) chance of easing, depending on the upcoming inflation and labour data. If inflation cools and the job market softens, we expect 25 bps cut in both September and December. If not, the Fed may stay put longer.
Trump’s 25% tariff ups trade tensions
On July 30, US President Donald Trump announced a 25 percent tariff on Indian goods while threatening a yet-to-be-specified penalty for buying Russian oil and arms.
While he called India a “friend”, he pointed to tariffs on US products and America’s large trade deficit with India (around $46 billion).
The decision caught many off guard, especially as both nations had been in trade talks. A new round of negotiations is scheduled for mid-August.
India’s response has been cautious. New Delhi reaffirming commitment to a fair and balanced trade deal, while stressing the need to protect farmers, MSMEs and key domestic sectors.
The newly imposed tariffs are expected to weigh on India’s economy, with a potential worst-case impact of up to 30 bps on GDP. Key export sectors such as textiles, gems & jewellery, and seafood (particularly shrimp) are likely to bear the brunt of higher duties. The broader macroeconomic impact will hinge on the scale of foreign institutional investor (FII) outflows. In the near term, the rupee is also likely to face, potentially prompting intervention from the RBI.
However, details remain scarce, especially around penalty amounts and potential exemptions in key sectors such as pharma, autos, electronics, and steel. All eyes are on a potential trade deal by September-October to ease tensions and secure better terms.
What next?
We expect the RBI to stay on hold on August 6 and in October, waiting to get a clear read on the monsoon, a critical input for food inflation. But come December, the pieces could finally fall into place for a rate cut.
Here’s why:
The RBI has already announced a phased 1 percent CRR cut from September to November, pumping Rs 2.5 trillion of durable liquidity into the system.
By December, we’ll also have better visibility on how the rate cuts are impacting credit demand and liquidity. Typically, it takes six to nine months for the transmission to flow into the system.
The US Fed’s direction would also be clearer, with markets pricing in just 25 -50 bps of cuts between October and December.
While Indian bond yields currently show a low correlation with US’ treasury movements, in the absence of strong domestic drivers, this relationship could regain relevance and begin to influence Indian bond yields once again.
Thus, the December policy meet could mark the RBI’s pivot point — inflation contained, growth steady and liquidity more flush.
(Sneha Pandey is fund manager-fixed income at Quantum Asset Management Company.)
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